Suppose that you want to form a long position of a bull spread using the two...

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Suppose that you want to form a long position of a bull spread using the two call options. Call 1 K = $90 T-1 year Call 2 K = $110 T-1 year Both options share the same underlying (non-dividend paying) stock whose current price is $100 per share. The volatility of the stock return is known to be 25% per annum. The risk-free rate is 2% per annum with continuous compounding. All Black-Scholes-Merton assumptions hold. (a) (3 pts) What does it cost to establish the bull spread per contract (i.e.. on 100 shares)? (b) (4 pts) How would you make this option portfolio delta neutral? Specify your hedging strategy using the underlying stock. (c) (3 pts) Suppose that tomorrow the price of underlying stock rises to $105 per share. How would you keep delta-neutrality of the portfolio you created in (b)? Suppose that you want to form a long position of a bull spread using the two call options. Call 1 K = $90 T-1 year Call 2 K = $110 T-1 year Both options share the same underlying (non-dividend paying) stock whose current price is $100 per share. The volatility of the stock return is known to be 25% per annum. The risk-free rate is 2% per annum with continuous compounding. All Black-Scholes-Merton assumptions hold. (a) (3 pts) What does it cost to establish the bull spread per contract (i.e.. on 100 shares)? (b) (4 pts) How would you make this option portfolio delta neutral? Specify your hedging strategy using the underlying stock. (c) (3 pts) Suppose that tomorrow the price of underlying stock rises to $105 per share. How would you keep delta-neutrality of the portfolio you created in (b)?

Answer rating: 100% (QA)

a To establish the bull spread per contract on 100 shares we need to calculate the cost of each call option Call 1 with a strike price of 90 Using the ... View the full answer